Timothy Geithner, the embattled US treasury secretary, won a burst of approval from the financial markets last night as Wall Street stocks rose sharply on a $1tn proposal for a partnership of public and private investment to rescue Wall Street's struggling banks.

In the biggest one-day rally since late October, the Dow Jones industrial average leapt by 497 points to 7,775‚ a rise of nearly 7%, as a clutch of encouraging economic figures fuelled a sense of relief that the Obama administration is poised to act on the financial crisis.

Last night Barack Obama announced that he would nominate veteran treasury department employee Neil Wolin as deputy treasury secretary. Wolin, who served as general counsel at the treasury from 1999 to 2001, was one of three senior nominees named by Obama.

In an initiative that forms the cornerstone of a long-awaited government strategy to tackle teetering financial institutions, Geithner proposed that the treasury would match private funds on a dollar-for-dollar basis to buy questionable loans and complex derivatives that have clogged up the banking system, blocking the flow of new loans and mortgages.

The proposal came at a crucial time for Geithner, who has struggled to fill positions in his team. Over the weekend, Barack Obama batted away suggestions that Geithner should resign, telling CBS's 60 Minutes: "He's got a lot of stuff on his plate. And he is doing a terrific job." Briefing reporters in Washington, Geithner acknowledged that there was "deep anger and outrage" that imprudent risks taken by financial institutions had contributed to a deep recession.

"That anger and outrage is perfectly understandable, and if we are going to get through this we need to engender more confidence in the American people that we are going to use taxpayers' money effectively and wisely to again help get credit flowing and help reduce borrowing costs," he said.

The treasury's proposals end a month of uncertainty, inertia and waning confidence.

Until last night's sharp rise in the Dow Jones, the financial markets had steadily declined as fears mounted for the future of vast institutions such as Citigroup and Bank of America, prompting certain economists to call on the White House for wholesale nationalisation of top banks.

Under the scheme, between $75bn and $100bn of public money will serve as seed capital. Hedge funds, private equity funds and other private partners will match taxpayers' funds.

Then the partnerships will be able to swell their firepower as much as sixfold by borrowing money, aided by a guarantee from the state-backed Federal Deposit Insurance Corporation, which is usually used to insure bank accounts.

The initial amount raised is expected to be $500bn, with a potential to expand to $1tn. The treasury hopes that participants will find long-term bargains in loans and securities that have proved impossible for banks to offload.

Geithner said the objective was to restore confidence in banks, allowing them to return to normal operations: "This will make it easier for them to raise capital privately because they'll have a cleaner balance sheet."

Obama said yesterday: "The good news is that we have one more critical element in our recovery, but we still have a long way to go and we have a lot of work to do."

Previous initiatives to shore up US banks have proved largely ineffective.

Two of the biggest investment houses on Wall Street, Pimco and Blackrock, lent their support to yesterday's proposals but others were more circumspect.

Adam Sussman, director of research at the financial consultancy Tabb Group, said: "The trillion-dollar question is whether the popular outrage over AIG bonuses and the 90% tax is going to scare some private investors away from investing alongside the government."